Column : Austere Budget and 'crowding out' effect

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K Vaidya Nathan : Feb 28 2013, 00:30 IST

The finance minister, a few days ago, indicated that he is planning to cut the public spending target for fiscal 2013-14 by up to 10% from this year’s original target, in what would be the most austere Budget unveiled in recent history as he tries to avert a sovereign credit downgrade. The finance minister has already slashed actual public expenditure in the current fiscal year by some 9% from the original target. So, the plan for 2013-14, at least on paper, seems to be to put a lid on spending.

The ministry has, in the past, not been able to achieve the austerity targets it set for itself. For instance, it missed its 2011-12 fiscal deficit target of 4.6% of gross domestic product by 1.2%, prompting threats of a downgrade from ratings agencies S&P and Fitch. India has a BBB minus rating with a negative outlook from both S&P and Fitch, the lowest investment grade rating possible. A cut would take our credit rating to junk status.

The finance minister, last Thursday, argued that a lower fiscal deficit will not only avert a rating downgrade threat but also bolster economic growth prospects as borrowing costs for private investors will fall, helping lift capital investment growth from a five-year low. The first reason about averting a rating downgrade is fine but I am not sure about the “crowding out” of private investment aspect. At least recent evidence doesn’t seem to suggest so.

Back in the 1990s, we knew why we feared deficits. They raised

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